Employee Dishonesty in Times of Recession: Safeguards and Proper Handling

1. 2010 Legal and Finance Series:Employee Dishonesty in Times of Recession: Safeguards and Proper HandlingTuesday, March 16, 2010

2. Employee Dishonesty in Times of Recession:Safeguards and Proper Handling Presented By: Chris Fereday, CRM Technology Practice Leader Telephone: (319) 234-8888 E-Mail: cfereday@midwesttechinsure.com www.midwesttechinsure.com

3. The Cost of Fraud • The U.S. Chamber of Commerce estimates that companies lose 1-2% of revenues annually due to fraud–mainly by employees • The Association of Certified Fraud Examiners estimate companies lose up to 6% of revenues annually through fraud • The cost of fraud comes straight off the bottom line–What is your profit margin?

4. Estimates of Losses Due to Fraud in 2009 37% of respondents estimated losses over $500,000 According to Association of Certified Fraud Examiners “Fraud Focus Poll” 2009

5. Vendor Fraud 39% of asset misappropriations are the result of billing schemes, which are most often vendor fraud

6. Why are Losses Increasing? • A decline in employee loyalty • Existing frauds being uncovered as systems are integrated • Increased opportunity for fraud when systems are not properly analyzed for the adequate segregation of controls • Management focusing on growth, margins, and new markets, not adequate control functions

7. Why are Losses Increasing? • Downsizing and Restructuring • Uncovers fraud when perpetrators can no longer hide their actions • Can result in an inadequate segregation of duties • Increases the moral hazard and decreases loyalty • Rapid Expansion and Globalization • Maintaining strong internal controls in remote operations has proven to be difficult at best • Auditing of international operations occurs at a lower frequency allowing losses to grow where controls are the most difficult to implement and monitor

8. The Impact of Computers on Fraud • The expansion of computers has: • Drastically changed the speed with which financial transactions and fraud can occur • Increased reliance on computers, thus reducing headcount and potentially impacting the segregation of duties • Made it difficult to detect fraud and abuse due to reliance on computers • Led many experts to associate increased reliance on computers with additional fraud expense According to AMSEC International

9. What Do the Surveys Say? • 80% of respondents thought that a significant incidence of fraud could occur at their organization* • 87% of respondents thought the incidence of fraud would increase or at best remain static over the next five years* • 67% of Certified Fraud Examiner (CFE) respondents think fraud is worse today than five years ago** According to Ernst & Young Fraud Survey* and The Association of Certified Fraud Examiners**

10. The Reality of Fraud • In the last 12 months more than two-thirds of respondents had suffered a fraud • 82% of all frauds were committed by employees, nearly 25% had been with the organization for over 10 years • Fraud is not limited by country or industry. 23 out of the 30 industries surveyed experienced losses in excess of $1,000,000 According to Ernst & Young Fraud Survey

11. Examples of Crime Losses Milwaukee Journal Sentinal, 12/21/2009Controller Embezzles $21 Million over 3 Years from Technology Firm Des Moines Register, 10/21/2009: Clive man arrested for fraud after alleged $1M embezzlement ComputerWorld, 4/18/00:HSBC: Data theft incident broader than first thought

12. Examples of Crime Losses Wall Street Journal, 9/20/00Starbucks Accuses Employee, Husband Of Embezzling $3.7 Million From Firm The Courier-Journal, 5/20/00:University of Kentucky Employee Admits to Embezzling More Than $1.5 Million

13. Examples of Crime Losses The Associated Press, 6/1200Executive Pleads Guilty to $6.9 Million Wire Transfer Fraud The Associated Press, 6/8/00: Consolidation of Payroll Reveals $7 Million Fraud at Prominent Large Manhattan Law Firm

14. What Can Companies Do? • Have senior management set the tone • Implement a written code of ethics policy • Have employees sign a conflict of interest statement • Actively support the internal audit process • Create an internal hotline for reporting fraud and abuse • Monitor management and owners through audits and internal hotline leads

15. What Can Companies Do? • Complete reference and background checks • Establish written guidelines for: • Verifying the existence of new vendors • When competitive bids are required • Verification that services were provided prior to payment • Audit the implementation of corporate policies and guidelines

16. Investigating Employee Theft and Fraud Becky S. Knutson Davis Brown Law Firm

17. Paperwork and Procedures • Initial procedures. For any handling of funds - cash, check, credit, electronic transfers, or other forms of funds - at least two people should regularly review and check the records. Reviews should be conducted independently. Outside reviewers, such as auditors, should review and check records periodically. • Employee absences and departures. For many reasons, employees should take vacation and leave time. This is a good time to have another employee perform funds functions, and check for irregularities and compliance with rules. When an employee departs, a check or audit should be done of fund handling matters, as well as any other functions performed. Many times, problems - whether deliberate or accidental - are discovered after an employee departs. Prompt review, especially while a departing employee is still present, may enable an employer to identify issues. • Record checks. Transactional records, reports, internal accounting and similar records should be provided and reviewed both internally and externally. Such records should be provided to management regularly, such as in monthly balance sheets, income and expense statements, departmental budget reports and similar reports. • Electronic and computer records. Employers should notify employees in their policies that anything on a company computer, and anything coming through any electronic communication - computer, hand held device, PDA, or any other equipment or account - is subject to monitoring. Prohibit inappropriate content and messaging, and check for transmissions or storage of employer information to or at another source.

18. When Something Seems Wrong • If something seems wrong - cash flow not as projected, bills unpaid, complaining creditors or clients, employees being overprotective of electronic records or computers, unusual emails out of a system - it is time to start checking. Don’t stop with only one question. Look into the records far enough to determine if there is only one problem, or if something more is at issue. • Ask questions of all involved. Have a person outside of the regular process contact customers or clients, vendors, bankers and similar persons to determine the complaints and their history. Have a person outside of the regular chain of command talk to employees. Be aware of your competitors and the prospect for employees leaving, and leaving with records or clients. • Get the records. Search for records - correspondence, statements, electronic records, invoices, and other records that should have been generated or may have been generated. Look in places where you might not expect to find records. Ask outside sources for copies of their records. Good recordkeeping, gathering and organization is essential to showing a chain or pattern of events, and tracing funds. The more that an employer can find, the more accurate the ultimate findings can be. • All records may not be available immediately. Sometimes, individual employee records, such as bank records or credit card records, will be required. This may require the assistance of outside sources, like law enforcement.

19. Identifying the Cause of the Problem • If an employee is suspected - keep that person out of the investigation and record search. Depending on the nature of the issue, and degree of proof, reassignment or suspension may be appropriate. • Consult your outside sources for investigative help. Attorneys, accountants, information technology or others who are independent, and can assist with legal or technical advice are essential. • Determine whether the issue is one of procedure, mistake or deliberate action. This may be a very subjective determination, and care should be taken to be accurate in making any conclusions.

20. Dealing With Employees • Keep all investigations confidential. As with any employee matter that may result in discipline, keep information confined to those persons with a need to know. • Review employee disciplinary policies. Most should treat theft and fraud as offenses resulting in immediate termination. • As allegations of deliberate dishonesty, rather than inefficient, ineffective or incompetent performance, are very serious, be certain of the facts before confronting the employee or reporting dishonesty. • Follow good investigation procedures. Be clear, thorough, and complete. Give an accused employee the opportunity to explain. Interview all persons who may have relevant information. • Security. Make certain that all relevant records are preserved. They may be needed for unemployment compensation hearings or future lawsuits. Keep suspected and accused employees from access to electronic or other records that may be taken, altered or destroyed.

21. Reporting • When the problem has been identified, determine who must be notified. For theft issues, or fraudulent claims, the employer’s insurance carrier should be notified promptly. Most insurance policies require that claims be made during the policy period in order to be covered, so prompt action is essential. • Depending on the nature of the problem, law enforcement authorities may be notified. Depending on the nature of the issues, law enforcement authorities may also conduct an independent investigation. • Be careful in making allegations of employee dishonesty as untrue accusations may be considered defamation.

22. Covenants Not to Compete and Severance Agreements Becky S. Knutson Davis Brown Law Firm

23. Covenants Not to Compete and Severance Agreements What are they? • They are contracts between employer and employee • They define conduct and obligations both during and after employment ends

24. Covenants Not to Compete and Severance Agreements What do they require? • Written agreement – clear and designed to meet purpose • Consideration for contractual agreements

25. Covenants Not to Compete and Severance Agreements What do they protect?  • “Protectable interests,” • Confidential information, trade secrets and proprietary information, • Competition by persons with a competitive advantage.

26. Trade Secrets Trade secrets are protected by Iowa Code Ch. 550, the Uniform Trade Secrets Act and by common law. • Trade secrets can range from customer information, to financial information, to information about manufacturing processes to the composition of products. There is virtually no category of information that cannot, as long as the information is protected from disclosure to the public, constitute a trade secret. • We believe that a broad range of business data and facts which, if kept secret, provide the holder with an economic advantage over competitors or others, qualify as trade secrets. US West Communications, Inc. v. Office of Consumer Advocate, 498 N.W.2d 711, 714 (Iowa 1993) (citations omitted).

27. Trade Secrets Common law elements of such a claim are: …“(1) existence of a trade secret, (2) acquisition of the secret as a result of a confidential relationship, and (3) unauthorized use of the secret.”

28. Trade Secrets Factors considered: (1) the extent to which the information is known outside of [the] business; (2) the extent to which it is known by employees and others involved in [the] business; (3) the extent of measures taken . . . to guard the secrecy of the information; (4) the value of the information [to the business and its competitors]; (5) the amount of effort or money expended . . . in developing the information; (6) the ease or difficulty with which the information could be properly acquired or duplicated by others.

29. What Should A Covenant Not to Compete Contain? • Reasonable restrictions related to the business • Recitation of reasons supporting the restrictions • Definite terms of restriction

30. Covenant Not to Compete How are they enforced? • Voluntary Agreement – with employee, future employers • Injunction – act quickly when violation is known. • Consider enforcement as written • Consider re-writing covenant if needed

31. Severance Agreements • Think about them at the time of hiring if restrictive covenants are to be used • Make them consistent with restrictive covenants • Be careful about exceptions • Conform them to your policies

32. Legal Considerations • Do you need a release? • “Global releases” and dismissals, covenants not to sue • Consideration • Confidentiality clauses • Consistency

33. Additional Q & A